On Importance of Location in Operating Model Design

Despite the recent profound changes in globalisation reach, management science and cultural awareness, location is perhaps one of the operating model areas of interest that is often taken for granted and not challenged during the process of operating model design and implementation.

In many instances, business location is driven by personal views and preferences, as opposed to business logic – where directors live or prefer to live, for example. For these businesses location is a so called “given” and this results in description of where functions operate and no more. What really is needed for the examination of locations is the rationale for the locations chosen and a challenge to whether the location either adds value to the customer experience or provides financial advantage.

The location area of the Operating Model Canvas is present to challenge the status quo and check the reasons why particular business locations exist and ask if they still make sense. It poses one important question – “Are the original drivers that placed the operation here still valid, or has this now become outdated and threatens strategic survival”?

There are many things to consider when reviewing existing or potential locations. Some common challenging questions include:

Are we here because the skills or cultural requirements we need are part of the local employment pool?

Has supply and demand of labour changed the underlying reason we came here in the first place?

Once clarity emerges around what should stay where it is and what can and should be relocated elsewhere, four essential options become visible:

Knowledge Proximity

Market Proximity

Resource Proximity

Tax/Legal Structure Optimisation

The well-established industrial economic location theory gives us two of those by stating that the operation ought to be located either close to its resources/inputs (supply side) or near to its markets (demand side), the location chosen depending on the nature of those resources or markets. A classic example is aluminium production, a process that uses large amounts of electricity, meaning refining plants are sited near to hydro-electric sources and to ports for the import of bauxite. In the industrial revolution, where coal as an energy source was required in bulk and being heavy to transport meant that the smelting of metals like copper, iron and steel tended to be located on a coal field and also near sea/river ports: Swansea in South Wales and the Ruhr in Germany being good examples.

The development of the knowledge economy revolution added two more locational options – knowledge availability (e.g. industry clusters such as Silicon Valley in California or Science and Technology Parks near Cambridge in the United Kingdom) and structural optimisation (e.g. for tax or legal reasons). All these options are well known and should require little additional explanation. Experience also tells us that these four options are as valid for service companies as for manufacturing firms.

What is crucial in contemporary Operating Model Design, is the potential impact of choosing any of the above options on both the value delivery chains to intended beneficiaries and on finances of the organisation. In other words, there will be a trade-off between these options – sometimes considerable – which needs to be well understood and modelled for its impact.

The graphic below illustrates likely impacts for each location option.

Unsurprisingly, the two original economic theory options of market and resource proximity are likely to have most impact (positive or negative) on company financials. However, whereas market proximity is likely to produce more impact on the delivery of the value proposition to its intended beneficiaries, resource proximity is less visible to final consumers and is is likely to have a less effect on the experience of value. In fact, excessive focus on resource proximity for service companies can have a pronounced detrimental effect on successful value delivery, as the UK’s Financial Services industry discovered (see the callout box).

Is location important to service organisations? Where the operations serve the customer directly like in hospitality then obviously yes, but where the service is provided at arm’s length via voice or data communication what then? The location question in these environments is a balance between staff costs and service quality. In the nineties, a drive towards cost leadership in many financial services driven by volume led to organisations extensively off-shoring their customer service and back office functions. The arbitrage of cheap labour costs, in places like Chennai and Bangalore, resulted in major operating model changes and subsequent job losses in developed western economies. The strategic choices made by organisations to leverage the cost leadership model resulted in mergers and acquisitions to seek scale supported by this location dominant operating model. “Big and bland” became the norm and as time progressed labour costs increased in these locations minimising savings and the customers rebelled against cultural misalignment between their needs and the providers cost focused approach. Today we see a reversal in this approach, with many organisations bringing these operations back home close to their markets and their customers.

The other two location options – knowledge proximity and structure optimisation are likely to have lesser overall financial impact. Of the two, knowledge proximity is able to ensure greater value delivery advantage through the application of the latest thinking and “creative sparks” being available earlier due to cross-pollination and the exchange of ideas. This is especially true in the case of digital businesses, where, despite common perception of their virtual nature, there are still real people involved in making things happen through sophisticated knowledge.

In most cases of knowledge proximity, HR resource cost is not a consideration simply because the costs of these skills are rapidly equalising across the globe. It is access to centres of excellence and associated clusters that really matters, thus prompting companies to centralise knowledge in a few chosen specialist locations.

Structure optimisation is usually more important from the internal overhead and/or taxation reduction standpoints and, while increasingly relevant at a certain stage in corporate development, contributes little – if anything – to value delivery process. In some recent cases, locational choices based purely on taxation advantage have created brand damage and reputational risk which has devalued value propositions due to media and political backlash. Google, Starbucks and Amazon are well publicised examples. In these cases, the lack of corporation tax paid due to structural decisions has resulted in summons to the parliamentary public accounts committee and extreme media focus, with some customers boycotting these organisations as a result.

Although this article is limited to selection of geographic locations in high level Operating Model design, the principles discussed here would apply equally well to team or department placing and even workshop floor organisation. For example, where to place Sales, Finance or HR teams is often a matter of heated debate in many organisations, with the loudest or more influential getting their way. In reality, placing these teams with due consideration to their role in the overall value delivery chains will better contribute to the overall effectiveness and efficiency of the live operating model.

To conclude, many companies today are located where they are for ‘historic’, rather than business logic based reasons. When there are several location options exist, the optimisation of corporate locations based primarily on standard management theories would be a step in the right direction. Our message in this article, however, is that considering locations’ role in firm’s value delivery chains, as well as purely a cost issue, is essential in effective operational design. As a leading operational design methodology, the Operating Model Canvas toolbox ensures that this issue is given due attention and analysis.

Finally, one other rationale for changing locations beyond the hard financial factors or value delivery logic must also be mentioned. Many companies are increasingly asking themselves: “Is our culture and history holding us back? Would a fresh start with new open-minded workers allow us to rebuild a reinvigorated operation?” and choose to shed their ‘old skin’ by moving away and starting afresh. This is perhaps extreme but must be acknowledged.

Location as a topic is invariably linked with organisational structure and reporting lines and both themes are instrumental in successful operating model design and implementation. We shall investigate organisational design issues in a subsequent article.